Short-term U.S. government borrowing costs eased on Tuesday after a steep fall in crude oil that followed reports of diplomatic progress aimed at ending the U.S.-Iran confrontation. The move reduced market expectations that the Federal Reserve will need to tighten policy at its next meeting in mid-September.
Oil sank more than 5% to a three-week low after Qatar said mediators were making headway in efforts to end the conflict. Officials also signaled forward movement on discussions to reopen the Strait of Hormuz, with Treasury Secretary Scott Bessent and Secretary of State Marco Rubio indicating progress in talks related to that channel.
While these developments raised hopes that a resolution could be nearing, market participants remained guarded given the history of several false starts in negotiations.
On the Treasury market, the yield on the two-year note - which tends to track expectations for the Fed's policy rate - fell 6.22 basis points to 4.194% and touched 4.1897%, its lowest level since July 20. The benchmark 10-year yield dropped 5.72 basis points to 4.627%.
The spread between the two- and 10-year Treasury yields narrowed to 43 basis points as the curve flattened.
Rising crude earlier in the conflict had fueled speculation that the Fed might be compelled to raise interest rates to offset upward pressure on prices, a concern underscored by data showing price growth remains above the central bank's 2% objective. Traders were also parsing comments from Fed Chairman Kevin Warsh last week, who highlighted inflation risks but did not provide a detailed plan for addressing them.
Futures markets adjusted their view of the September Federal Open Market Committee meeting: fed funds futures were pricing in about a 59% chance of a rate hike on September 15-16, down from 68% on Monday.
Market indicators cited in trading screens included: sharp declines in Brent crude and moves in short- and long-dated Treasury yields consistent with a pullback in rate-hike expectations.
Investors remain attentive to further diplomatic developments and inflation signals that will influence both energy markets and U.S. interest-rate expectations.